Equity Analysis /
Egypt

Raya Contact Center (RCC): Revenue declines on a stronger EGP, shift in revenue mix pressures margins

    Raya Contact Center (RACC) reported 1Q19 revenues of EGP228.0 million, up from EGP213.3 million in 1Q18 and down from EGP236.4 million in 4Q18; an increase of 6.9% YoY and a decline of 3.6% QoQ. The QoQ decline in revenues was mainly on a stronger EGP, where EGP/USD averaged EGP17.66/USD in 1Q19, compared to EGP17.97/USD in 4Q18; given that more than 70% of RACC’s revenues are foreign currency denominated. RACC reported organic growth in FCY revenue of 5% YoY in constant-currency terms.

    RACC added c.218 workstations in 1Q19 mainly in the downtown facility and divested the number of WS in Poland to c.135 WS in 1Q19, down from c. 248 WS in 2018, bringing the total number of WS to 6,796 in 1Q19, up from 6,688 in 2018. Total Capex/Sales represented 2.4% in 1Q19 vs 2.0% in 1Q18. Utilization rate in 1Q19 hit 83%, up from an average utilization of 76% in 2018.

    Sequential shift in revenue mix drove margin contraction and weakened profitability

    During 1Q19, RACC witnessed:

    • Higher local currency revenue contribution (+2.2pps QoQ, +2.3pps YoY), representing 26.1% of total revenues.
    • Lower foreign currency contribution (-2.2pps QoQ, -2.3pps YoY), representing 73.9% of total revenues, down from 76.1% and 76.2% in 4Q18 and 1Q18 respectively.
    • Higher revenue contribution of the lowest margin business line “Insourcing” to record 17.5 % of total revenues (+1.4pps QoQ, +3.9pps YoY), where Insourcing posted a growth of 38% YoY.
    • On the contrary, RACC’s core business line and the second highest margin business line (Outsourcing) showed lower revenue contribution of 61.9% (-4.3pps QoQ, -10.6pps YoY) and showed a decline of c.8.7% YoY.
    • Finally, lower revenue contribution of local operations to 26.1% of total revenues, known to be the highest margin; mainly on Egypt financial attractiveness and cheaper labor cost compared to UAE and Poland. Local Operations contribution to revenues showed declined QoQ and marginally increased YoY (-1.1pps QoQ, +0.3pps YoY), despite recording a 7.3% YoY increase, mainly on higher Dubai revenue contribution.
    • Dubai operations recorded 12.2% YoY increase in revenues, contributing to 25.1% of total 1Q19 revenues (+1.4pps QoQ, +1.2pps YoY).
    • Polish operations continue to show weak operations and lower contribution to RACC’s revenues in 1Q19 (-0.3pps QoQ and -1.5pps YoY) at 1.5%.

    Expansions also drove rent expense up. Rent Expense surged by 70.8% YoY and 25.1% QoQ, representing 12.3% of total revenues, up from 9.6% and 8.0% in 4Q18 and 1Q18 respectively; mainly on aggressive expansions.

    Direct personnel expense showed an acceptable QoQ increase (+0.8pps QoQ), representing 48.2% (as % of revenues) in 1Q19, up from 47.4% in 4Q18 and down from 50% in 1Q18.

    Margins contracted aggressively on higher contribution of low margins business lines, unfavorable geographical revenue contribution  and lower foreign currency contribution to revenues, where:

    • EBIT margin dropped by 4.8pps YoY and by 2.9pps QoQ to record 18.1%, mainly on a much higher rent expense.
    • NPM dropped by 6.4pps YoY and by 1.7pps QoQ, to record 16.0%, where a lower effective tax rate (-1.0pps YoY and -1.7pps QoQ; (on higher revenue contribution from Dubai) couldn’t offset the weakness from the operating level. 

    Finally, RACC achieved economies of scale and management efforts to curb cost inflation has prevented further margin dilution by lowering G&A/S&M expenses as percentage of revenues (by 0.6pps, 0.1pps YoY, respectively).

    Favorable expansion shields margins and lifts valuation; but not enough to curb a stronger EGP 

    RACC confirms plans to continue expanding its international business hoping to maintain higher allocation to  Egypt due to its cost attractiveness and is expected to enter the Saudi market this year with a 100 seat facility and expand its Dubai operations by adding another 100 seats. It is worth noting that we are yet to incorporate both the new smart village building and the Saudi venture into our model, as we await more detailed guidance from the company. Smart Village facility is expected to accommodate around 750 seats by 2019, out of which 200-300 seats will be operational by 2Q19. Favourable expansion mix that assures faster expansion in Egypt than in Dubai and Poland shields margins and valuation, despite witnessed margin dilution.

    However, RACC’s operations are very sensitive to EGP/USD movements, as witnessed in 1Q19. Margins were negatively impacted by a stronger EGP, given that more than 70% of RACC’s revenues are USD denominated.

    Recent developments and their potential impact on valuation

    We are currently reviewing our assumptions to take into account the shift in revenue mix, tighter margin, stronger EGP and planned expansions. We’ve run a quick initial exercise to gauge the impact on valuation given the recent developments, taking into account the following changes:

    • Direct employee cost as percentage of revenues of 55.0% at perpetuity, compared to our previous direct employee cost as percentage of revenues assumptions of 50.0% at perpetuity.
    • EBITDA margin of 18.5% at perpetuity, compared to our previous EBITDA margin assumptions of 22.7% at perpetuity.
    • Announced expansions together with expected margin contraction, higher rent expense and higher direct employees expense as percentage of revenues would increase our FV by c. EGP1.0-1.5/share; ignoring the impact of any EGP appreciation.
    • Hypothetically, if EGP averaged 17.0 during 2019-2022, and then depreciated to reach our previous expectation of 22.67 by 2023, current FV drops to EGP15.36/share (check table 3 below).
    • A blended impact could initially result in a downgrade in FV of c. EGP1.5/share.

    Stock performance penalized by market sentiment and low liquidity 

    RACC’s recent developments and margin contraction will add pressure to stock price, despite trading at cheap multiples compared to global peers. However, RACC will be able to maintain its competitive advantage over global peers on faster local than foreign expansion and higher contribution of offshore contracts to revenues. RACC approved a DPS of EGP0.85; implying DY of 6.5% in 2018. RACC currently trades at 2019f P/E of 7.3x; which is at a sharp discount of global peers average of 2019f P/E of 13.24x.